You need a Plan B, IMF tells Osborne

Growth to fall well below Government's predictions, while rethink of austerity drive urged if downturn continues

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A slowdown in Britain's austerity drive will have to be considered by the Government if economic growth continues to stall, the International Monetary Fund warned yesterday.

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Britain and Germany were told by the IMF that they may have to take a dramatic change of course if growth undershoots "current expectations". The Fund underlined the precarious state of the economy as it downgraded its forecast for growth this year to just 1.1 per cent.

Its prediction – and the suggestion that the Chancellor, George Osborne, may have to contemplate an economic "Plan B" – provoked angry clashes between the Government and Opposition and fuelled tensions within the Coalition. As ministers look for ways of breathing fresh life into the flagging economy, the Business Secretary, Vince Cable, urged the Bank of England to press ahead with a new round of quantitative easing, or printing money. It also emerged that ministers believe an extra £5bn could be injected into the economy without undermining their debt reduction programme.

The IMF said the economy is set to fall drastically short of the Government's growth expectations, calculating that Britain will grow by just 1.1 per cent this year and 1.6 per cent in 2012.

The twice-yearly IMF report, published yesterday in Washington, explicitly advised the Government against cutting further. It suggests that if UK growth turns out to be even weaker than its present projections, the Chancellor should be prepared to slow the pace of deficit reduction in order to support the economy in the near term.

The IMF report said: "If activity were to undershoot current expectations, countries that face historically low yields [Germany and the UK] should also consider delaying some of their planned adjustment." However, Jorg Decressin, an IMF staff member, stressed yesterday that a change of course from the Treasury should only take place if growth threatens to slow down "substantially".

Ed Balls, the shadow Chancellor, said: "These are deeply concerning forecasts for both the UK and world economy. Our Chancellor and political leaders in Europe need to wake up to the scale of the problem and finally realise we need economic growth and more people in work to really get deficits down."

The Treasury countered that the IMF was forecasting that the UK will grow more strongly than Germany, France and the eurozone next year. But it added: "It is clear that the UK is not immune to what is going on in our biggest export markets, with every major economy seeing lower forecasts for growth this year and next."

Both Conservative and Liberal Democrat sources insisted the Coalition remained committed to the Government's austerity drive. But differences are emerging, with Liberal Democrat figures saying they feared the Tories did not grasp the depth of the crisis. Conservative sources believe that the gloomy note sounded by Mr Cable could backfire by undermining confidence in the Government's strategy.

The IMF report, in its World Economic Forecast, is another heavy blow to the credibility of the Chancellor's deficit reduction plans. At the time of his most recent Budget in March, the Office for Budgetary Responsibility forecast that the British economy would grow by 1.7 per cent this year and 2.5 per cent next year.

The head of the OBR, Robert Chote, announced that the Government was broadly on course to meet its target of eradicating the bulk of the deficit by 2015. But the growth predictions on which that verdict was based are now looking impossibly optimistic.

If the UK economy expands at the lower rate projected by the IMF, the private sector will struggle to create enough new jobs to offset the 490,000 that are scheduled to be cut from the public sector. That will mean unemployment benefit payments coming in higher than projected, and the Government will have to borrow more to pay them. That, in turn, will mean that the deficit does not come down on the planned timetable. Slower than expected growth since the Chancellor's first Budget in June 2010 has already caused the Chancellor to project £45bn more in borrowing by 2015 than he originally anticipated.

The IMF's forecast is merely the latest in a long line of downgraded UK growth projections. Earlier this month the OECD said British growth was likely to come to a virtual halt this year.

The Chancellor faces a fateful choice: he can either announce that his deficit reduction targets for this parliament are unlikely to be met, which would be politically embarrassing, or he can announce that the Government will step up its pace of deficit reduction with more spending cuts and tax rises in an attempt to get back on target.

The problem with the latter course is that it would run the risk of undermining a weak British economy still further, possibly even tipping the UK back into recession.